Two firms produce luxury sheepskin auto seat covers: Western Where (WW) and B.B.B. Sheep (BBBS). Each firm has a cost function given by

C(q) = 30q + 1.5q²

The market demand for these seat covers is represented by the inverse demand equation

P = 300 ‒ 3Q

where Q = q₁ + q₂, total output.

a. If each firm acts to maximize its profits, taking its rival’s output as given (i.e., the firms behave as Cournot oligopolists), what will be the equilibrium quantities selected by each firm? What is total output, and what is the market price? What are the profits for each firm?

b. It occurs to the managers of WW and BBBS that they could do a lot better by colluding. If the two firms collude, what will be the profit-maximizing choice of output? The industry price? The output and the profit for each firm in this case?

c. The managers of these firms realize that explicit agreements to collude are illegal. Each firm must decide on its own whether to produce the Cournot quantity or the cartel quantity. To aid in making the decision, the manager of WW constructs a payoff matrix like the one below. Fill in each box with the profit of WW and the profit of BBBS. Given this payoff matrix, what output strategy is each firm likely to pursue?

d. Suppose WW can set its output level before BBBS does. How much will WW choose to produce in this case? How much will BBBS produce? What is the market price, and what is the profit for each firm? Is WW better off by choosing its output first? Explain why or why not.

Transcribed Image Text:

PROFIT PAYOFF MATRIX BBBS (ww PROFIT, BBBS PROFIT) PRODUCE PRODUCE COURNOT q CARTEL q Produce Cournot q w Produce Cartel g PROFIT PAYOFF MATRIX BBBS (ww PROFIT, BBBS PROFIT) PRODUCE PRODUCE COURNOT q CARTEL q Produce Cournot q w Produce Cartel g